Dynamic Monitoring Design

This paper introduces flexible endogenous monitoring into dynamic moral hazard. A principal can commit to not only an employment plan but also the monitoring technology to incentivize dynamic effort from an agent. Optimal monitoring follows a Poisson process that produces rare informative signals, and the optimal employment plan features decreasing turnover. To incentivize persistent effort, the Poisson monitoring takes the form of “bad news” that leads to immediate termination. Monitoring is non-stationary: the bad news becomes more precise and less frequent. When persistent effort is not required, the optimal incentive scheme features a trial period of non-stationary monitoring, and a combination of Poisson bad news that leads to termination and Poisson good news that leads to tenure.